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Canadian Board Members and Cyber Expertise: New U.S. Bill Proposes Board Level Cybersecurity Expertise - Could Canada Move in the Same Direction?

January 18, 2016

Lawmakers south of the border are seeking to force public issuers to disclose cybersecurity expertise at the board level in an effort to improve cybergovernance as the number of reported cyber risk incidents continues to climb. While the Canadian approach to date has been different, Canadian regulators have made clear their expectations that board-level involvement and engagement is, in their view, critical.

Two U.S. Senators have proposed a bi-partisan bill that would require public issuers to disclose the cybersecurity expertise on the issuer’s board of directors or explain why cybersecurity expertise on the board is not necessary.

The effects of a cyber threat can erase market capitalization and weaken a company’s reputation amongst consumers. Mass data breaches are increasingly resulting in class action lawsuits against organizations as well as their officers and directors. For example, Target directors and officers are facing multiple shareholder derivative actions related to the retailer’s highly public data breach claiming breach of fiduciary duty, waste of corporate assets and gross mismanagement.[1] Shareholders of Wyndham Worldwide Corporation filed a similar D&O claim that in 2014 that was eventually dismissed.[2]

Cybersecurity is no longer a backroom topic. However, despite the ever-present risk of a cyberattack, it appears the topic is not regularly considered at the board level, in the U.S., Canada, elsewhere.[3] It is against this background that the U.S. bill was introduced.

Background

The Cybersecurity Disclosure Act of 2015 introduced last month seeks to encourage the prioritization of cybersecurity at reporting issuers by implementing a comply or disclose regime, with the goal of stemming the ever-increasing tide of cyber threats to publically listed companies.[4]

The bill is short and to the point. It seeks only to implement a comply or disclose regime by requiring the reporting issuer to disclose either (a) whether a member of its board (or other governing body) has cybersecurity expertise; or (b) if no member of the board has such expertise, to describe the cybersecurity measures that were taken into account by members responsible for identifying the qualifications of board nominees (i.e. explain why cybersecurity expertise is not needed at the board level).

Interestingly, the legislation does not define what qualifications would meet the threshold for cybersecurity expertise. Instead, if passed, the Securities Exchange Commission and U.S. National Institute of Standards and Technology will be tasked with determining a benchmark to determine cybersecurity expertise.

The bill is now before the U.S. Senate Committee on Banking, Housing and Urban Affairs.

Critical Reception

Opinions are divided on the usefulness of the proposed bill. Some academics from Harvard and Columbia believe that the bill represents a fair “light touch approach” and is merely a “regulatory nudge”.[5] On the other hand, other commentators have noted that the bill undermines board flexibility and is an attempt to provide a one-size fits all solution that may not be appropriate for a number of companies.[6] Despite the differing viewpoints, the proposed bill has reinvigorated the cybersecurity discourse and specifically the role of boards of directors and is sure to pique the curiosity of Canadian regulators.

The Canadian Approach

Presently, no similar legislation exists or is proposed in Canada and, with the exception of financial literacy requirements, Canadian legislation does not mandate specific technical expertise on boards.[7] However, various regulators have released guidance for their constituents on protecting against cybersecurity risks.

For example, the Canadian Securities Administrators (“CSA”) released SN 11-326 – Cyber Security which suggests, among other things, that issuers should specifically review their cybercrime risk and regularly review their cybersecurity risk control measures. Similarly, as detailed in earlier posts here and here, the Investment Industry Regulatory Organization of Canada (“IIROC”) and the Office of the Superintendent of Financial Institutions (“OSFI”) have each released guidance on cybersecurity. The IIROC offering went so far as to provide a best practices guide with respect to cybersecurity risk oversight, which identifies the need for sound governance and board engagement as being “essential” to effective enterprise-wide cybersecurity and board-level and senior management-level engagement as being “critical”.

Senior management at Canadian banks and insurance companies are expected to review cyber risk management policies to ensure effectiveness under a 2013 OSFI memorandum to Federally Regulated Financial Institutions. The memo outlined a self-assessment guidance template, which OSFI may require an institution to complete, that includes a section on “Senior Management & Board Oversight.” The relevant questions include whether a Senior Management committee has been established dedicated to cyber risk, whether Senior Management provides funding to implement the cyber security framework, which processes escalate to Senior Management cyber incidents, and whether the Board or a committee of the Board is engaged in regularly reviewing the implementation of the framework.

In addition, it is becoming increasingly common for Canadian reporting issuers to reference cybersecurity risks in their annual securities disclosure documents or public offering documents. In its 2015 Best Practices for Proxy Circular Disclosure Guidance, the Canadian Coalition for Good Governance (“CCGG”) suggests that boards should disclose the processes used which enable them to identify and monitor risk management efforts. With respect to cybersecurity, the CCGG made note of DH Corporation’s efforts to provide specific disclosure with respect to cybersecurity risk, in which DH Corporation disclosed its practice of briefing the board on cyber risks on a quarterly basis.

Canadian issuers are not unfamiliar with how comply or disclose regimes operate. For instance, recent amendments to NI 58-101 – Disclosure of Corporate Governance Practices, require issuers, in certain provinces, to comply or disclose their practices with respect to the level of representation of women in senior executive positions and on boards. The most recent report from the CSA notes that nine months after the comply or disclose amendments to NI 58-101, 15% of affected issuers added one or more women to their board, and approximately 15% of the largest issuers affected (those with market capitalizations greater than $2 billion) revised or adopted specific policies regarding the representation of women in senior roles.[8] Given the relative short period of time since implementation, it appears that Canadian issuers are, in theory, able to effectively respond to comply or disclose requirements.[9]

It remains to be decided whether legislation is required to mandate specific technical experience in order to combat cybersecurity risk at the board level or whether continued non-binding guidance and best practice guides are sufficient to ensure proper board engagement in Canada.

What is certain is that issuers are operating in an environment where cybersecurity risk is becoming an increasingly hot-button issue that requires real and substantial consideration at the board level. In 2014,thirty-six percent of Canadian companies reported one or more substantial cyberattacks in the past year alone, according to a think tank that tracks data breaches and their ensuing costs to organizations.[10] Preliminary 2015 figures suggest even more cyber incidents involving sensitive information with increased frequency of cyberattacks and more expensive data breaches.[11] Canadian companies should, at a minimum, ensure their boards are aware of the cybersecurity risks faced by the enterprise and that management has a proper policy in place to deal with a potential security breach.

[3] Ponemon Institute, 2015 Global Megatrends in Cybersecurity (February 2015). According to the study, approximately 22% of 1006 security professionals surveyed had provided a board briefing on cybersecurity in the preceding 12 months.

[9] It should be noted that there is an appreciable difference between seeking to broadly enhance diversity (as is the case with NI 58-101 amendments) and seeking to legislate the specific expertise needed at an organization.